The international Fisher effect (sometimes referred to as Fisher's open hypothesis) is a hypothesis in
international finance
International finance (also referred to as international monetary economics or international macroeconomics) is the branch of financial economics broadly concerned with monetary and macroeconomic interrelations between two or more countries. Inter ...
that suggests differences in
nominal interest rates reflect expected changes in the spot
exchange rate
In finance, an exchange rate is the rate at which one currency will be exchanged for another currency. Currencies are most commonly national currencies, but may be sub-national as in the case of Hong Kong or supra-national as in the case of t ...
between countries.
The hypothesis specifically states that a spot exchange rate is expected to change equally in the opposite direction of the interest rate differential; thus, the
currency
A currency, "in circulation", from la, currens, -entis, literally meaning "running" or "traversing" is a standardization of money in any form, in use or circulation as a medium of exchange, for example banknotes and coins.
A more general ...
of the country with the higher nominal interest rate is expected to depreciate against the currency of the country with the lower nominal interest rate, as higher nominal interest rates reflect an expectation of
inflation
In economics, inflation is an increase in the general price level of goods and services in an economy. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation corresponds to a reduct ...
.
Derivation of the International Fisher effect
The International Fisher effect is an extension of the
Fisher effect hypothesized by American economist
Irving Fisher
Irving Fisher (February 27, 1867 – April 29, 1947) was an American economist, statistician, inventor, eugenicist and progressive social campaigner. He was one of the earliest American neoclassical economists, though his later work on debt de ...
. The Fisher effect states that a change in a country's expected inflation rate will result in a proportionate change in the country's interest rate
:
where
:
is the
nominal interest rate
:
is the
real interest rate
: